1. Executive Summary 1.

1 Background to the Abnormally Low Tender (ALT) Working Group Report (Report Section 2) The SECTEUR report (Strategic Study on the Construction Sector, Final Report, St rategies for the Construction Sector) was published in 1993 with the objective of improving the competitivenes s of the European construction industry. This was followed in 1996 by the Document of the Services of the Commi ssion Concerning the Results and Follow-up of the Strategic Study of Construction, which identified over 100 possible actions to realise the objectives of the SECTEUR report. In November 1997 the Commission adopted a Communication to the Council, the Euro pean Parliament, the Economic and Social Committee and the Committee of the Regions on the competitiv eness of the construction industry.1 The objective of the Communication is to analyse the main elements af fecting the competitiveness of the sector and to propose measures to improve it. Four key strategic objectives are stated as well as 65 specific actions. In the Communication, the Commission declares its intention, in co-oper ation with European industry representatives and Member States, to put progressively into place an action pla n to implement these recommendations. The Industry Council at its session of May 1998 adopted conclusions on the Commu nication. After recognising the importance of the construction industry, welcoming the Commissions initiative and supporting the four key strategic objectives, the Council invited the Commission to discuss the proposed measures with Member States and industry with the aim to develop an action plan and to present a repo rt about the discussions to the Council within one year. The priorities for an action plan were considered with industry representatives at a meeting with the Commission on 27 October 1998. Discussion concentrated on 16 main priority actions identifi ed at two previous meetings between the Commission and industry representatives. It was agreed that, as a pa rt of the action plan, DG III would convene a working group to examine and make recommendations on the followi ng priority: to permit fair competition by making use of mechanisms to detect and rule out ab normally low offers. The Working Group has met on five occasions: 12 November 1998; 16 December 1998; 5 February 1999; 19 March 1998; 19 May 1999. Joint rapporteurs were FIEC and CEETB. Representatives from the following European organisations participated and we are indebted to them for their suppor t and valuable contributions: CEA (Comit Europen des Assurances) CEETB (Comit Europen des Equipements FETBB (Fdration Europenne des Travailleurs du Btiment et du Bois) Techniques de Btiment) CEPMC (Council of European Producers of Materials FIEC (Fdration de lIndustrie Europenne de la Construction) for Construction) ICIA (International Credit Insurance Association) EBC (European Builders Confederation) CE DG III

CE DG XV The Working Group regretted that European clients were not represented at any of the meetings. This report reflects the majority view of the participants at the meetings. In s ome circumstances unanimity was not possible. Where disagreement of a participant was sustained a footnote has b een included giving the initials of the dissenting participant together with the reason for disagreement with the majority view. Within the Report emphasis has been placed on existing Directives and public pro curement. However, the Working Group is mindful that this Report is the result of the follow-up to the SECTEUR report, which addressed the competitiveness of the whole European construction industry encompassing bot h public and private sectors. 1 COM (97)539 final DG3 alt wg 06.doc 050699 4 The Working Group is also aware that its work has been constrained by lack of re sources which would have permitted more comprehensive research. Consequently, we have had to rely on prev ious work, the views and opinions expressed by participants, and information provided voluntarily. The an d wishes to improve its competitiveness and the achievement of that objective would be greatly assisted by the provision of resources by the EC. The Working Group considers that this Report is only an interim statement of the views of the industry in relation to the prevention, detection and elimination of ALTs. Further work is necessary and the Recommendations contain the methodology by which more comprehensive and effective actions could be brought about. 1.2 The adverse effects of ALTs (Report Section 3) ALTs have adverse effects on all parties in the construction industry. Enterpris es that submit ALTs are more likely to suffer financial loss leading to excessive pressures to save costs and reduce expenditure on quality, investment, innovation, training, working practices and health and safety. These effects are passed on through the supply chain to sub-contractors, suppliers, other service providers and empl oyees. SMEs are particularly vulnerable to the adverse effects of ALTs because of their more limited financia l resources and commercial strength2. In an industry as important as construction, the poor profitability and inadequa te resources of enterprises caused by ALTs have consequential effects on national economies and international compe titiveness. Clients, owners, users and operators of the construction works are also affected because an ALT can lead to poor value for money3. By considering only the lowest possible construction pric e there is a much greater possibility that the costs in use, maintenance and replacement costs (life cycle costs) will be higher. The possibilities for prevention of ALTs are greatest at the upper levels of the supply chain. Whilst all parties have a responsibility to remedy the problems caused by abnormally low tenders it is clients that, ultimately, have the best opportunities to solve the problems. 1.3 An abnormally low tender (Report Section 4)

Article 30 of Public Works Directive 93/37/EEC concerning the award of public wo rks contracts makes reference to ALTs and how they should be dealt with: (1) The criteria on which the contracting authorities shall base the award of con tracts shall be: (a) either the lowest price only; (b) or, when the award is made to the most economically advantageous tender, var ious criteria according to the contract: e.g. price, period for completion, running costs, pro fitability, technical merit. (...) (4) If, for a given contract, tenders appear to be abnormally low in relation to the works, the contracting authority shall, before it may reject those tenders, request, in writing, detail s of the constituent elements of the tender which it considers relevant and shall verify those constituent ele ments taking account of the explanations received. Some countries define ALTs by arithmetic deviation from an average price but the re can be no assurance that such methods accurately identify an ALT. Similarly, there is little guidance ava ilable that enables tender award on the basis of the economically most advantageous tender, especially in the hig hly regulated public procurement sector. This report is intended to provide a way forward that would allow a more systematic, consistent and auditable assessment of tenders to meet the criterion of economic ally most advantageous tender (EMAT) and thus prevent ALTs at source. 2 FIEC: Not logical, as also SMEs can sub-contract and therefore pass on low pri ces to others in the contractual chain. 3 FIEC: ALTs do not necessarily affect quality, which is safeguarded by technica l regulations and contractual legislation. DG3 alt wg 06.doc 050699 5 1.4 Recommendations for the prevention of ALTs (Report Section 7) 1. More rigorous application of the qualitative legal, economic and technical se lection criteria set out in Articles 24-28 of Public Works Directive 93/37/EEC is necessary4. A European Sta ndard for the qualification of construction enterprises, as mandated by the European Commissio n to the European standards organisations CEN and CENELEC, will be based on these criteri a and help their proper application. 2. Procurement systems should be used that ensure that enterprises bear some res ponsibility for quality and performance of the completed works which would lead to the EMAT. Thi s would also be assisted by the early involvement in the design phase of the main participant s in the construction process, particularly technical contractors5. 3. Partnering, that is to say long-term relationships based on clear measurement of performance and sustained improvement of quality and efficiency6, should be encouraged to achiev e best overall value for money. The ALT WG acknowledges that this aim is covered by other prior ity actions identified by the industry and Member States but nonetheless recognises that the principle of partnering would help prevent ALTs.

4. Tender documentation must be clear and unambiguous. 5. Adequate time must be allowed for the preparation of tenders. 6. Preliminary reports indicate that surety bond systems covering bid, performan ce and payment (as used in the US, Canada and some other countries) are very effective in deterring the submission of unrealistic tenders. However, constraints on the resources and time available to the ALT WG prevented a comprehensive analysis of possible adaptation to the European enviro nment. It is therefore recommended that this work should be developed and progressed by a separate Surety Bond working group charged with evaluation of the feasibility of such a s ystem and its possible effectiveness in the context of the European construction industry. A p aper outlining a possible European surety bond system is included at Appendix 37 which could be u sed as a starting point for the proposed working group. 7. The prohibition of post-tender negotiations should be respected. A bid deposi tory system exists in several Canadian provinces which prevents the abuse of post-tender negotiations. Consideration should also be given to the applicability of such a system in Europe. This could be achieved by a special working group set up for the purpose or be e ncompassed by the Surety Bond working group referred to above. 8. Contracts should be awarded to the EMAT (economically most advantageous tende r). It is recommended that a separate EMAT working group be established charged with the production of an effective and publicly auditable mechanism that permits award t o the EMAT, not just the lowest initial price. An example of a mechanism that evaluates tenders on the basis of quality, value and whole life costs is outlined in Appendix 28 which could be us ed as a starting point for the proposed working group9. If tenderers are aware that such examination will be a matter of routine the eff ect will be to prevent ALTs in the first place. 9. Changes to the works during construction must be limited to avoid speculation that the potential losses of an ALT may be recoverable through the additional costs of such changes . 10. Public works legislation should be amended so that sub-contractors may benef it from the principles of transparency and non-discrimination presently enjoyed only by principal contr actors10. 11. Preferential treatment of public entities must be ruled out. 4 FETBB: In addition to qualitative legal economic and technical selection crite ria the compliance with social provisions in the whole contractual chain is essential for the prevention of ALT. 5 FIEC: It is the principal contractor who has the contractual relation with the client and who bears overall contractual responsibility towards the client. This implies that any direct contacts with the client are limited to the scope of the contractual relationship. 6 FIEC: Bears risks, in particular for SMEs, concerning a fair and efficient com petition on the market. 7 Preliminary comments on a European contract bond system. A paper produced by C

EA/ICIA 27 May 1999 8 Construction Quality and Value: discussion paper to promote the concept of bes t value, not lowest price. J R Harrower, 29 November 1998. 9 FIEC: This "EMAT scoring system" may well be an example of a possible system. However, it is in a very early stage of discussion and has not yet been used to any extent. Consequently, nothing can be said concerning it s feasibility and efficiency in detecting the economically most advantageous tenders. The issue is, of course, worth being looked at but is so complex that FIEC is of the view of a specific and thorough discussion/analysis before any recommendation can be formulated. 10 FIEC: EU public procurement Directives concern the co-ordination of procedure s for the award of public works contracts and it is not their aim to deal with private contractual relationships. DG3 alt wg 06.doc 050699 6 12. Peaks and troughs in supply and demand should be smoothed by more effective and consistent long term planning of expenditure by public authorities. 13. The awareness of clients of the adverse effects of ALTs should be raised. Cl ients should be encouraged to take advantage of the unique opportunities they have to prevent AL Ts. 1.5 Recommendations for the detection of ALTs (Report Section 8) 1. A possible mechanism to detect an ALT would be any tender differing by a cert ain percentage (ten per cent would be appropriate) from a combination of the clients estimate an d from the average of the tenders11. This could, if necessary, be corrected in order to avo id being distorted by tenders that might be too high in relation to the average. 2. An objective statistical method to determine the threshold below which a bid has to be considered as abnormally low is included at Appendix 4. The threshold can be determined bas ed on the dispersion parameters of the fair price and on an analysis of the global amounts of the previous tenders. Hence, the authorities can disregard the abnormally low tenders in an o bjective and indisputable way. 3. It is recognised that the above detection mechanisms are open to error and di stortion. Therefore, if the objective is tender award to the EMAT, the only way to be sure that the EMAT is identified is by examination of the lowest two or three tenders in every case, w hatever the deviations from the average might be. 1.6 Recommendations for the elimination of ALTs (Report Section 9) 1. Directive 93/37 requires that suspected ALTs are explained. The wording is, h owever, ambiguous as it states that The contracting authority may take into consideration....... Thi s wording should be made more specific by addition of the word only (may only take into consideration.. .....). 2. A suitable mechanism for examination and explanation of tenders is attached a t Appendix 2, (see also 1.4 Prevention of ALTs, Recommendation 8 above). As already stated, the onl y way to be sure that the EMAT and not an ALT is accepted is by examination of the lowest tw o or three tenders in every case, whatever the deviation from the average might be. 3. Directive 93/37 is silent on unexplained ALTs although their rejection is imp

lied. Provided assessment of the EMAT is carried out on all tenders as a matter of routine and in accordance with the above recommendation, detection and rejection of ALTs would be automatic. 11 FIEC: Any fixed percentage rates or other "arithmetical methods" are arbitrar y. According to FIEC s survey only a minority of countries (B, GR, I) use an arithmetic system and furthermore there is no information at all c oncerning their efficiency. DG3 alt wg 06.doc 050699 7 2. Background to the ALT Working Group Report 2.1 SECTEUR Strategic Study on the Construction Sector In 1993 the European Commission published the SECTEUR report (Strategic Study on the Construction Sector, Final Report, Strategies for the Construction Sector) which included the followi ng observations relevant to any examination of the problem of ALTs. 1.7 Supply: the quality and value-for-money of construction in most countries ca n be improved. Clients are often dissatisfied, and this directly affects demand for construction. There are also large potential savings in cost and time, which would enable a larger real contribution to be made with the resources available. Construction quality and value-for-money should be raised through training, inno vation, standards, better procurements, guarantees and control. 1.22 Quality is considered in many EC member states to be a basic problem of the industry. Lack of quality has two distinct aspects: defects of either design or workmanship. A certain level of problems is inevitab le, but excessive problems are a consequence of poor care and attention to detail, poor supervisio n and control, or insufficient definition of the clients needs; a low level of specification: in other words sacrificing performance, long life, appearance or long-term operating costs for lower initial costs. These are deliberate decisions taken as a consequence of shortterm vision, high financing costs, or inefficient cut-throat competition. 1.23 There is a general belief that both aspects should be improved in order to: raise the quality of the built and indoor environment; reduce life-cycle costs of construction, by reducing maintenance and redevelopme nt costs, and shifting construction output away from high-cost maintenance activities to efficient newbuild activities; reduce the costs of defects, including the costs of re-work and repairs as well as the administrative and legal costs; make construction a less risky activity for clients and hence promote investment in good construction; give EC constructors and product manufacturers a reputation and technical advant age which will contribute to improving export capabilities. 1.24 In particular, it is important that the sector, particularly designers and contractors, should be able to compete on quality and not just on price. Among the proposals that would contribute to i mprovement in quality are: improved procurement procedures, which take account of quality, and life cycle c osts, and bidders capabilities and past performance, not just lowest initial cost. 1.57 The nature of construction makes the free market mechanism inefficient. Thi

s is why all countries have building regulations and planning controls to ensure essential minimum levels of building quality and to control land speculation. There are still characteristics, however, which tend t o bias demand towards low quality and unrealistic low prices. In particular the time lag between contract and completion and the fact that most projects are to some extent unique, means that clients have incomplete knowledge of the product they are purchasing. This can lead to myopic choice, selection on price rather t han quality, and underbidding with a reliance on later claims and litigation. Combined with easy entry for new firms, and volatile markets so that established firms have to defend their market share agg ressively in recessions, this leads to cut-throat competition, which depresses quality and profitability. 1.58 Cut-throat competition also, regrettably, leads to an element of murky pract ices to evade the disciplines of the market. 1.59 Whereas governments can regulate to control prices and the quality of servi ce in monopolistic industries where competition is inadequate, they are not able to regulate to control excess ive competition. They can, however, ensure that systems exist to make sure that those who practice in the i ndustry have proper qualifications and their capabilities are registered, to prevent excessive compe tition from debasing quality. 1.67 Public bodies also have a special duty to act as ideal clients, by using pr ofessional procurement techniques in which: quality is as important as price; life-cycle costing is applied to safeguard the future; DG3 alt wg 06.doc 050699 8 professional designers and consultants are properly used and selected; training is ensured; innovation is encouraged; only properly qualified and registered firms and individuals are employed; and fair prices and contract terms are applied. 6.3 Unrestrained competition in construction creates a bias to low levels of spe cification. There are two consequences: firstly, consistent underbidding by contractors and consultants leads them to se ek all possible ways to cut corners and reduce the level of specification wherever it is not rigorously specified; secondly, the customer has a bias towards low initial cost rather than life time cost, because of the uncertainty deriving from a lack of perfect foresight about the future performan ce of the built works. 2.2 Results and Follow-up of the Strategic Study of Construction The EC published a further document in 1996 (Document of the Services of the Com mission Concerning the Results and Follow-up of the Strategic Study of Construction) which identified t hree fundamental policy goals for the sector. Two of those goals are of particular relevance to ALTs: to improve the quality of construction in all its aspects through better design, adaptation to the needs and performance of the works to stricter standards and more effective products, while reducing defects and improving consumer protection;

 to improve the quality/price ratio (value for money), which will lead to greater c ompetitiveness of the sector. The fundamental objectives were developed into a series of strategic actions, in cluding: In the field of competitiveness, the quality/price ratio of the sector has to be improved, implying greater reliability in the services provided to the customers. Construction products sho uld be competitive, especially by a process of elimination of barriers, which would encourage trade. For quality, the technical specifications of construction works will have to be enhanced gradually and in an on-going way in order to reduce defects and the cost of non-quality. For the structure of the sector, the strategic study says that intervention shou ld not be direct but that flexibility should be encouraged, the aim of this being the coexistence of a lar ge number of small specialised enterprises, of local companies and of a number of large-scale compa nies which could be leaders in export markets. Very small enterprises must have better profitability and qualification for work. The strategic actions are at the root of more than one hundred recommendations s ent to all the agents of the sector. A summary of the recommendations is not reproduced here but is to be fou nd in Annex A to the above document. Annex B of the same document summarises the comments and reactions fro m the sector. 2.3 Communication on the competitiveness of the construction industry On 4 November 1997 the Commission adopted a Communication to the Council, the Eu ropean Parliament, the Economic and Social Committee and the Committee of the Regions on the competitiv eness of the construction industry. The Industry Council, at its session of 7 May 1998, adopted the conclu sions of the Communication and invited the Commission to discuss the proposed measures with Member States and in dustry with the aim to develop an action plan and to present a report about the discussions to the Coun cil within one year.